Russia, emerging markets rebound post-Crimea

Longer-term investors may need deep pockets, warns analyst

MADRID (MarketWatch)—Russian stocks saw their best day in just over two weeks on Monday, driving other emerging markets higher as the fallout from a controversial referendum on Crimea so far has not triggered as severe sanctions by Western powers as expected.

Investors remain braced for more volatility, though, with Russia stocks in particular viewed cautiously by many strategists in an emerging-market picture that is fogged by China growth concerns as well.

Crimea votes overwhelmingly to join Russia

(2:23)

Crimeans voted overwhelmingly on Sunday to break away from Ukraine and join Russia, according to preliminary results of a referendum that the West condemned as illegal. Photo: AP

Russia’s blue-chip MICEX index
XX:MICEXINDEXCF
rallied 3.6% to 1,285.85, the best daily gain since March 4, when it closed up over 5%. Gains stretched across the European emerging-market space, with the Turkey ISE National 30 index up 1.6% and Hungary’s BUX index jumping 3%.

European and U.S. stocks also rebounded from losses seen Friday and a bruising week overall.

As Russia stocks climbed, the ruble clawed back some ground as well, gaining 0.8% against the dollar
USDRUB, +0.0000%
to 36.27 and the 0.5% against the euro
EURRUB, +0.0000%
to 50.55.

Crimea’s parliament passed a vote to proclaim the region an independent state and seek to re-join Russia as a republic, after a region-wide referendum resulted in an overwhelming majority of voters opting to break away from Ukraine. The results of the referendum have been declared illegal by the West. European leaders who came out with some guidelines for sanctions on Monday.

The European Union imposed sanctions on 21 Russian and Ukraine leaders who they see as responsible for the referendum, The Wall Street Journal reported. However, the markets rallied, including European and U.S. stocks from related recent losses as those sanctions are not as severe so far as some had feared. The U.S. also announced sanctions on Russian and Ukraine leaders, which will block interests and property in the U.S., including assets.

Russian stocks have performed the worst on a global scale this year, down 23%. Some of last week’s biggest-losing days took the index back to levels not seen since May 2012. Analysts such as J.P. Morgan’s Adrian Mowat are among those who have been calling for investors to sell stocks. He said a recent decision by the Russian Central Bank to hike interest rates will hit both the economy and stocks.

Analysts also cited as positive, reports that the Russian government has called on Ukraine to draft a new federal constitution granting broader powers to the country’s different regions to protect minority populations.

Bank of America Merrill Lynch laid out two scenarios for Russia on Monday. In the first, and in the worst-case Russia would announce the annexation of Crimea and individuals and Russia itself would suffer serious sanctions, with counter-sanctions on U.S./EU businesses.

In the second, Russia doesn’t rush to formally annex Crimea and instead uses it as a bargaining tool, with Russia avoiding more serious sanctions as long as it stays out of Crimea. While Russia has signalled it will annex Crimea quickly, sanctions so far have not been as intense as some had expected.

Bank of America analysts said they expect the country will manage to avoid serious sanctions, and projected risk assets would rally, as they did on Monday. But they also cautioned that “trapped long” positions on Russian stocks will likely return as sellers in Russia act on such a move, as the country’s investment climate has suffered a blow and redemptions on those stocks will continue.

Reuters

A woman holds a Russian flag Sunday as she casts her ballot during the referendum on the status of Ukraine's Crimea region at a polling station in Bakhchisaray.

Chris Weafer, senior partner at Macro-Advisory Ltd., said in emailed comments that investors will be watching Russia’s response to sanctions and whether Russia would make any moves into East Ukraine.

“Most investors believe East Ukraine to be the red-line in terms of economy destroying sanctions,” said Weafer. “Today’s list will likely still be in the inconvenient category, e.g. visa bans and asset freezes against targeted individuals, whereas the sanctions response to an East Ukraine incursion would be much more severe.”

Craig Erlam, senior strategist with Alpari U.K., said emerging markets are “a dangerous game given that the Fed is showing no desire to slow the pace of tapering,” with Ukraine and China’s growth concerns all rolled into that. Therefore the year ahead will be turbulent for emerging markets and short-term players could get burned.

Of course, any sell-off such as what has been seen will create opportunity, but buyer beware, he says.

“All of these are going to make it a turbulent year for the emerging markets, making it quite difficult,” he said. “Anyone getting involved for longer term returns may need deep pockets at times because I certainly don’t think we’ve seen the last of the volatility in these markets,” Erlam said in emailed comments. Also see: The case for buying emerging markets

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